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Wednesday, April 22, 2009

Editor's Note: Here is a piece discussing a possible short squeeze put on by Goldman Sachs. The SEC is only concerned about an up-tick rule when it comes to market manipulation, but why isn't a squeeze just as detrimental to the markets?

The rally in SPG this week didn’t seem like typical short-covering. The activity was especially poignant if you were short SPG, like me, and got your head stomped. Today’s action looked like someone put in a market order to buy 2,000,000 shares, smashing through even the loosest stops. At the same time, several power-players who list Simon Properties as clients, are issuing Strong Buy recommendations. Coincidence?

In this environment, who would want to buy SPG? It’s a highly-leveraged mall REIT with total exposure to consumer spending. Their debt/equity ratio is an eye-popping 5.93. They have $770 million in cash as of 12/31/08, with total on-balance sheet debt of $18 billion, plus another $6 billion off-balance sheet from their joint-ventures (it’s on page 83 of that 10-k, and is non-recourse). They have $19b in assets, which consist of shopping malls and centers. There’s also a large investment in Liberty, a UK REIT, that has soured and not been written down. Yet I keep hearing about their strong balance sheet from some analysts.

The economy couldn’t be much worse for a Mall-REIT like Simon. Unemployment is still on the rise, and prior months are quietly being revised upwards. Consumer spending is plummeting, cost of capital is soaring, and retail vacancies are increasing as more stores go belly up. Inflation may eventually benefit Simon, but that’s still a good way off.

Time to bring out the big guns

Yesterday Goldman Sachs added Simon to their Conviction Buy List with a target of $46. This rec came exactly 3 weeks after Goldman, UBS, and Deutsche Bank completed a big offering equity/debt offering for Simon. GS held $177 million worth of SPG as of 12/31/08. RREFF America LLC , a subsidiary of Deutsche Bank, held $330 million.

The basic gameplan for a investment bank bank like Goldman might look something like this:

Borrow dirt-cheap money from the Fed

Loan that money to risky commercial real-estate companies by underwriting juicy offerings (10.35% for the Simon debt, equity was at $31.50, an ~8% discount to current price).Collect fees from client(s), plus interest from the spread on the debt. If there’s not enough demand for the stock, keep it yourself, then proceed to steps 4 and 5.

Research dept adds stock to Conviction Buy List

If GS traders and Quant-funds were to brutally squeeze the stock higher, that would be icing on the cake for the whole deal, hypothetically. What’s to stand in the way? Dennis Gartman and a few dozen retail investors?

Sounds very profitable, and pretty foolproof to me. Unless, of course, the SEC gets involved and finds something wrong, like they did in 2003. That incident resulted in $110 million in fines for GS. Here are some excerpts:

The Complaint also alleges that Goldman Sachs published exaggerated or unwarranted research and failed to maintain appropriate supervision over its research and investment banking operations.

Goldman Sachs “aligned” its research, equities, and investment banking divisions to work collaboratively in order to fully leverage its limited research resources.

Goldman Sachs failed to establish and maintain adequate policies, systems, and procedures reasonably designed to ensure the objectivity of its published research.

At this point, I’d like to clarify that my suspicions are just that. I have no proof of any wrongdoing, and don’t claim to. But this looks suspicious.

S&P Likes SPG Too (and also list them as a client)

Standard and Poors is bullish on SPG, and have been on a feverish reiteration crusade lately. At least once a week they remind us that they have a Five-Star, Strong Buy rating on their client, Simon Properties. They’ve maintained this rating since the stock was at $107.33. It closed around $47 today. So why do they keep reiterating? A jaded person might say they’re just pumping for their clients. The opposing argument, I suppose, is that they’re dollar-cost-averaging on their rec?

So, are Goldman and the boys just toying with the retail shorts here? I think so, and if I were an analyst, my target price for Simon would be zero. Too much debt, horrific environment to be in. But my opinion means squadoo, and we have no idea how long this rally could last.

Remember that our markets are not rational, fair, or efficient. And that is not likely to change. Banks are entrenched in Washington, and they’re going to defend their position of power ferociously. So hedge, hope you’re trading with the Quants and big boys, and try to be lucky with your timing.

Posted by
Mike Morgan

1 COMMENTS:

Anonymous
said...

Being short the REITS is like Movie Gallery bonds back in 2006/2007. Back then Goldman bought a bunch of bonds in front of them underwriting a new credit facility. The new bank loans initially traded well while the bonds soared ripping the faces off the shorts nearly hitting par. I remember getting many calls that day from my Goldman sales coverage to buy the bonds everytime they ticked higher. A few months latter .Movie Gallery ended up filing for bankruptcy months later and the bonds were trading for pennies on the dollar.

With the REITS. the Golden Scrote has brought their dirty credit market tricks to the equity market. Stocks are now trading the way the old high yield market used to trade during the end of the credit bubble.

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